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OVBC > SEC Filings for OVBC > Form 10-Q on 11-Aug-2014All Recent SEC Filings

Show all filings for OHIO VALLEY BANC CORP

Form 10-Q for OHIO VALLEY BANC CORP


11-Aug-2014

Quarterly Report


ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

(dollars in thousands, except share and per share data)

Forward Looking Statements

Except for the historical statements and discussions contained herein, statements contained in this report constitute "forward looking statements" within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Act of 1934 and as defined in the Private Securities Litigation Reform Act of 1995. Such statements are often, but not always, identified by the use of such words as "believes," "anticipates," "expects," and similar expressions. Such statements involve various important assumptions, risks, uncertainties, and other factors, many of which are beyond our control that could cause actual results to differ materially from those expressed in such forward looking statements. These factors include, but are not limited to:
changes in political, economic or other factors such as inflation rates, recessionary or expansive trends, taxes, the effects of implementation of the Budget Control Act of 2011 and the American Taxpayer Relief Act of 2012 and the continuing economic uncertainty in various parts of the world; competitive pressures; fluctuations in interest rates; the level of defaults and prepayment on loans made by the Company; unanticipated litigation, claims, or assessments; fluctuations in the cost of obtaining funds to make loans; and regulatory changes. Additional detailed information concerning a number of important factors which could cause actual results to differ materially from the forward-looking statements contained in management's discussion and analysis is available in the Company's filings with the Securities and Exchange Commission, under the Securities Exchange Act of 1934, including the disclosure under the heading "Item 1A. Risk Factors" of Part 1 of the Company's Annual Report on Form 10- K for the fiscal year ended December 31, 2013. Readers are cautioned not to place undue reliance on such forward looking statements, which speak only as of the date hereof. The Company undertakes no obligation and disclaims any intention to republish revised or updated forward looking statements, whether as a result of new information, unanticipated future events or otherwise.

Financial Overview

The Company is primarily engaged in commercial and retail banking, offering a blend of commercial and consumer banking services within southeastern Ohio as well as western West Virginia. The banking services offered by the Bank include the acceptance of deposits in checking, savings, time and money market accounts; the making and servicing of personal, commercial, floor plan and student loans; the making of construction and real estate loans; and credit card services. The Bank also offers individual retirement accounts, safe deposit boxes, wire transfers and other standard banking products and services. In addition, the Bank is one of a limited number of financial institutions that facilitates the payment of tax refunds through a third-party tax software provider. The Bank has facilitated the payment of these tax refunds through electronic refund check/deposit ("ERC/ERD") transactions. ERC/ERD transactions involve the payment of a tax refund to the taxpayer after the Bank has received the refund from the federal/state government. ERC/ERD transactions occur primarily during the tax refund season, typically during the first quarter of each year. Loan Central also provides refund anticipation loans ("RALs") to its customers. RALs are short-term cash advances against a customer's anticipated income tax refund.

For the three months ended June 30, 2014, the Company's net income decreased by $598, or 30.8%, as compared to the same period in 2013, to finish at $1,344. Earnings per share for the second quarter of 2014 also decreased by $.15, or 31.3%, compared to the same period in 2013, to finish at $.33 per share. For the six months ended June 30, 2014, net income decreased by $257, or 5.0%, to finish at $4,908, compared to the same period in 2013. Earnings per share for the first half of 2014 also decreased by $.07, or 5.5%, compared to the same period in 2013, to finish at $1.20 per share. The annualized net income to average asset ratio, or return on assets ("ROA"), lowered to 1.20% at June 30, 2014, as compared to 1.28% at June 30, 2013. The Company's net income to average equity ratio, or return on equity ("ROE"), also lowered to 12.03% at June 30, 2014, as compared to 13.45% at June 30, 2013.


The Company recorded higher net interest income during the three and six months ended June 30, 2014, increasing $346, or 4.4%, and $707, or 4.3%, respectively, over the same periods in 2013. The Company benefited from a stronger net interest margin, which increased to 4.46% during the three months ended June 30, 2014, and 4.49% during the six months ended June 30, 2014, as compared to 4.33% and 4.37% during the same periods in 2013, respectively. The primary reasons for net interest income and margin improvement include increasing average earning assets, a decrease in amortization expense on mortgage-backed securities and declines in higher-costing time deposits and subordinated debentures. These positive impacts completely offset the downward pressure on asset yields due to long-term interest rates remaining at historically low levels.

The largest contributor to the Company's lower net income results during both the second quarter and year-to-date periods ended June 30, 2014 was higher provision expense. During the three and six months ended June 30, 2014, provision expense increased $1,575 and $2,038, respectively, over the same periods in 2013. While the Company experienced lower net charge-offs and minimal change in nonperforming loans from a year ago, management determined an increase of general allocations was necessary related to various loan portfolio risks. Contributing most to this higher general allocation was the downgrade of two impaired commercial credits during the second quarter of 2014, which increased the Company's classified assets and economic risk factor within the calculation of the allowance for loan losses. Further discussion can be found under the captions "Allowance for Loan Losses" and "Provision for Loan Losses" within this Management's Discussion and Analysis.

Total noninterest income during the three months ended June 30, 2014 decreased $53, or 2.7%, while increasing $125, or 2.1%, during the six months ended June 30, 2014, as compared to the same periods in 2013. Quarter-to-date decreases were largely from lower service charge revenue and mortgage banking income. Year-over-year increases were largely from tax processing fees through ERC/ERD transactions and a $135 fee as part of an agreement to sell its pro rata share of ProAlliance Corporation ("ProAlliance"), a specialty property and casualty insurance company. These increases were partially offset by a 58.9% decrease in bank owned life insurance and annuity asset income compared to the first half of 2013.

Total noninterest expense during the three months ended June 30, 2014 decreased $320, or 4.4%, and decreased $973, or 6.4%, during the six months ended June 30, 2014, as compared to the same periods in 2013. Impacting both the quarter- and year-to-date results were lower salaries and employee benefits, foreclosure expenses and state taxes, which collectively decreased $251 and $629, respectively, from the same periods in 2013. The Company also incurred a fee of $212 during the first quarter of 2013 associated with the redemption of higher-costing, trust preferred securities, which was not repeated during the first quarter of 2014.

At June 30, 2014, total assets were $763,813, compared to $747,368 at year-end 2013, with the increase due mostly to a $21,599, or 3.8% increase in gross loan balances from year-end 2013. Total investment securities also increased 1.5% to $108,499 at June 30, 2014, compared to $106,894 at year-end 2013, mostly from purchases of mortgage-backed securities. Partially offsetting asset growth was a 28.4% reduction in interest-bearing deposits within the Company's Federal Reserve Clearing account that were generated from seasonal tax clearing activities during the first quarter of 2014.

Total liabilities were $679,440 at June 30, 2014, up $12,491 since December 31, 2013. Total deposit balances experienced continued growth during 2014, increasing $8,780 compared to year-end 2013. Interest-bearing balances accounted for $3,110 of the increase, impacted by municipal public fund deposit balances. Noninterest-bearing deposits accounted for $5,670 of the increase, resulting from excess deposits retained out of the seasonal increases in tax refund processing activities during the first quarter of 2014. At June 30, 2014, other borrowed funds were up 16.8% compared to year-end 2013.

At June 30, 2014, total shareholders' equity was $84,373, up $3,954 since December 31, 2013. Regulatory capital ratios remained significantly higher than the "well capitalized" minimums.


Comparison of Financial Condition at June 30, 2014 and December 31, 2013

The following discussion focuses, in more detail, on the consolidated financial condition of the Company at June 30, 2014 compared to December 31, 2013. This discussion should be read in conjunction with the interim consolidated financial statements and the footnotes included in this Form 10-Q.

Cash and Cash Equivalents

At June 30, 2014, cash and cash equivalents decreased $5,700, to finish at $22,644, compared to $28,344 at December 31, 2013. The decrease in cash and cash equivalents was largely affected by the Company's use of excess funds retained from seasonal tax deposits during the first half of 2014. The Company will generally experience higher levels of excess funds during the first quarter than any other part of the year due to increased tax refund deposits from its ERC/ERD tax business. Liquidity levels normalize during the second quarter as these short-term tax refund deposits are fully disbursed from its Federal Reserve Bank clearing account, leaving a portion of retained excess funds. The Company used its Federal Reserve Bank clearing account deposits to help fund the growing loan portfolio and maturities of retail certificates of deposit ("CD's"). The interest rate paid on both the required and excess reserve balances is based on the targeted federal funds rate established by the Federal Open Market Committee, which currently is 0.25%. This interest rate is similar to what the Company would have received from its investments in federal funds sold, currently in a range of less than 0.25%. Furthermore, Federal Reserve Bank balances are 100% secured.

As liquidity levels vary continuously based on consumer activities, amounts of cash and cash equivalents can vary widely at any given point in time. Carrying excess cash has a negative impact on interest income since the Company currently only earns 0.25% on its deposits with the Federal Reserve. As a result, the Company's focus will be to re-invest these excess funds back into longer-term, higher-yielding assets, primarily loans, when the opportunities arise.

Securities

The balance of total securities increased $1,605, or 1.5%, compared to year-end 2013. The increase came mostly from U.S. Government agency ("Agency") mortgage-backed securities, which increased $1,438, or 1.9%, from year-end 2013. The Company's investment securities portfolio is made up mostly of agency mortgage-backed securities, representing 70.7% of total investments at June 30, 2014. During the first half of 2014, the Company invested $8,041 in new Agency mortgage-backed securities, while receiving principal repayments of $7,327. The monthly repayment of principal has been the primary advantage of Agency mortgage-backed securities as compared to other types of investment securities, which deliver proceeds upon maturity or call date. However, with the current low interest rate environment, the cash flow is being reinvested at lower rates.

Loans

The loan portfolio represents the Company's largest asset category and is its most significant source of interest income. At June 30, 2014, gross loan balances finished at $587,918, an increase of $21,599, or 3.8%, from year-end 2013. Higher loan balances were mostly impacted by increased origination volume within the commercial and industrial loan portfolio, which grew $14,038, or 21.8%, from year-end 2013. Commercial and industrial loans consist of loans to corporate borrowers primarily in small to mid-sized industrial and commercial companies that include service, retail and wholesale merchants. Collateral securing these loans includes equipment, inventory, and stock. Commercial real estate loans comprise the largest portion of the Company's total commercial loan portfolio, representing 71.2% at June 30, 2014. Commercial real estate loans experienced an increase of $7,820, or 4.2%, from year-end 2013, largely within construction loans. While management believes lending opportunities exist in the Company's markets, future commercial lending activities will depend upon economic and related conditions, such as general demand for loans in the Company's primary markets, interest rates offered by the Company, the effects of competitive pressure and normal underwriting considerations. Management will continue to place emphasis on its commercial lending, which generally yields a higher return on investment as compared to other types of loans.


Residential real estate loan balances comprise the largest portion of the Company's loan portfolio at 36.2% and consist primarily of one- to four-family residential mortgages and carry many of the same customer and industry risks as the commercial loan portfolio. Residential real estate loan balances during the first half of 2014 decreased $1,279, or 0.6%, from year-end 2013. Movement within the real estate portfolio consists of decreasing long-term fixed-rate mortgages partially offset by increasing short-term adjustable-rate mortgage balances. Long-term interest rates continue to remain at historic low levels and prompted periods of increased refinancing demand for long-term, fixed-rate real estate loans, most recently during the second half of 2012. As part of management's interest rate risk strategy, the Company continues to sell most of its long-term fixed-rate residential mortgages to the Federal Home Loan Mortgage Corporation, while maintaining the servicing rights for those mortgages. Since 2012, the refinancing volume for long-term fixed-rate real estate loans has trended down, which contributed to a 52.5% decrease in real estate loans sold during the six months ended June 30, 2014 compared to the same period in 2013. A customer that does not qualify for a long-term, secondary market loan may choose from one of the Company's other adjustable-rate mortgage products, which contributed to higher balances of adjustable-rate mortgages from year-end 2013.

Consumer loan balances increased $1,020, or 1.0%, from year-end 2013. The Company has experienced declining trends within its automobile loan segment for the past several years due to competitive pressures with below-market interest rate offerings and alternative methods of refinancing. However, during the first half of 2014, auto loan balances increased $1,611, or 4.2%, from year-end 2013, due to loan origination volume increases. Further increases to consumer loans came from all-terrain vehicles and home equity lines of credit. The Company will continue to monitor its auto lending segment while maintaining strict loan underwriting processes to limit future loss exposure.

Allowance for Loan Losses

The Company established a $7,928 allowance for loan losses at June 30, 2014, an increase of $1,773, or 28.8%, from year-end 2013. These additional reserves were impacted mostly from general allocation increases impacted by the economic risk factors within the calculation of the allowance for loan losses. As part of the Company's quarterly analysis of the allowance for loan losses, management reviewed various factors that directly impact the general allocation need of the allowance, which include: historical loan losses, loan delinquency levels, local economic conditions and unemployment rates, criticized/classified asset coverage levels and loan loss recoveries. During the second quarter of 2014, the Company experienced a downgrade of two commercial credits that shifted $12,000 from a criticized loan classification to a classified loan classification. The two commercial credits are impaired and have been individually evaluated for impairment since year-end. As more current information became readily available, management determined the downgrades were necessary due to a continuing trend of decreasing cash flow coverage ratios of the borrower. As a result of higher classified assets, the economic risk factor increased, which required additional general reserves within the allowance for loan losses. While this impact was caused mostly by commercial loans, the higher economic risk factor at June 30, 2014 was applied to the entire loan portfolio, increasing the general allocations within the residential real estate and consumer loan portfolios, as well as commercial. Furthermore, during the first quarter of 2014, adjustments were made to the commercial loan loss factor, extending the range of loan loss period from a 3-year rolling average to a 5-year rolling average. This update was due to the significant decline in net charge-offs that have been experienced since the first quarter of 2012 that were contributing to a lower historical loan loss factor for commercial loans. By extending the historical loss period to five years, management feels the historical factor is more representative of the expected losses to be incurred on commercial loans. Management also increased its economic risk factor by adjusting its criticized/classified asset thresholds to incorporate more risk potential within the Company's special mention and substandard loan portfolios. As a result of the second quarter loan downgrades and the first quarter allowance calculation adjustments, the general allocation component of the allowance for loan losses increased $2,061, or 58.4%, from year-end 2013.


Specific allocations of the allowance for loan losses that identified collateral impairment of certain impaired loans decreased $288, or 11.0%, from year-end 2013. The Company also benefited from minimal change in its troubled assets, with nonperforming loans to total loans finishing at 0.63% at June 30, 2014, down 2 basis points from year-end 2013. The Company's nonperforming assets to total assets totaled 0.71% at June 30, 2014, an increase of 4 basis points from year-end 2013. Impaired loans at June 30, 2014 increased $3,578, or 24.3%, from year-end 2013, largely from the restructuring of a commercial and industrial loan relationship during the second quarter of 2014.

The ratio of the allowance for loan losses to total loans increased to 1.35% at June 30, 2014, compared to 1.09% at December 31, 2013. Management believes that the allowance for loan losses at June 30, 2014 was adequate and reflected probable incurred losses in the loan portfolio. There can be no assurance, however, that adjustments to the allowance for loan losses will not be required in the future. Changes in the circumstances of particular borrowers, as well as adverse developments in the economy are factors that could change and make adjustments to the allowance for loan losses necessary. Asset quality will continue to remain a key focus, as management continues to stress not just loan growth, but quality in loan underwriting as well.

Deposits

Deposits continue to be the most significant source of funds used by the Company to meet obligations for depositor withdrawals, to fund the borrowing needs of loan customers, and to fund ongoing operations. Total deposits at June 30, 2014 increased $8,780, or 1.4%, from year-end 2013. This deposit growth came primarily from interest-bearing NOW account balances, which increased $5,903, or 5.6%, during the first half of 2014 as compared to year-end 2013. This increase was largely driven by public fund balances related to local city and county school accounts within Gallia County, Ohio.

Deposit growth also came from noninterest-bearing deposit balances, which increased $5,670, or 3.8%, from year-end 2013. This increase was largely from growth in the Company's business checking accounts, particularly those that serve to facilitate the significant volume of ERC/ERD tax refund items during the first quarter of 2014. The Company is one of a few institutions that provide ERC/ERD processing for a tax software provider. During 2014, this software provider was successful in increasing the volume of its ERC/ERD transactions from the same period in 2013. These seasonal business checking account balances should continue to normalize during the remainder of 2014.

In the first half of 2014, time deposits decreased $4,123, or 2.4%, from year-end 2013. As CD market rates continue to adjust downward, the spread between a short-term CD rate and a statement savings rate has become small enough that many customers choose to invest balances into a more liquid product, perhaps hoping for rising rates in the near future. This change in time deposits from year-end 2013 fits within management's strategy of focusing on more "core" deposit balances that include interest-bearing demand, savings, money market and noninterest-bearing deposit balances.

While facing increased competition for deposits in its market areas, the Company will continue to emphasize growth and retention in its core deposit relationships during the remainder of 2014, reflecting the Company's efforts to reduce its reliance on higher cost funding and improving net interest income.

Other Borrowed Funds

Other borrowed funds were $21,901 at June 30, 2014, an increase of $3,153, or 16.8%, from year-end 2013. While deposits continue to be the primary source of funding for growth in earning assets, management will continue to utilize Federal Home Loan Bank advances and promissory notes to help manage interest rate sensitivity and liquidity.


Shareholders' Equity

The Company maintains a capital level that exceeds regulatory requirements as a margin of safety for its depositors. At June 30, 2014, the Bank's capital exceeded the minimum requirements to be deemed "well capitalized" under applicable prompt corrective action regulations. Total shareholders' equity at June 30, 2014 of $84,373 increased $3,954, or 4.9%, as compared to $80,419 at December 31, 2013. Contributing most to this increase was year-to-date net income of $4,908, partially offset by cash dividends paid of $1,722, or $.42 per share.

Comparison of Results of Operations for the Three and Six Months Ended June 30, 2014 and 2013

The following discussion focuses, in more detail, on the consolidated results of operations of the Company for the three and six months ended June 30, 2014 compared to the same periods in 2013. This discussion should be read in conjunction with the interim consolidated financial statements and the footnotes included in this Form 10-Q.

Net Interest Income

The most significant portion of the Company's revenue, net interest income, results from properly managing the spread between interest income on earning assets and interest expense incurred on interest-bearing liabilities. During the second quarter of 2014, net interest income increased $346, or 4.4%, as compared to the second quarter of 2013. During the six months ended June 30, 2014, net interest income increased $707, or 4.3%, as compared to the six months ended June 30, 2013. The improvement was largely due to a higher net interest margin impacted by increased average loans, lower amortization expenses on investment securities and lower funding costs.

Total interest and fee income recognized on the Company's earning assets increased $161, or 1.8%, during the second quarter of 2014, and increased $189, or 1.0%, during the first half of 2014, as compared to the same periods in 2013. Asset yields on the Company's earning assets have been negatively impacted by lower market rates and higher average balances within the Company's lower-yielding Federal Reserve Bank clearing account. As a result, the year-to-date earning asset yield at June 30, 2014 was 4.87% compared to 4.89% at June 30, 2013. Lower asset yields were offset by growth in average loans during the first half of 2014, increasing $23,877, or 4.3%, over the first half of 2013, driven mostly by the commercial loan portfolio. The Company further benefited from increased earnings within investment securities, which increased $124, or 27.0%, during the second quarter of 2014, and $222, or 24.6%, during the first half of 2014, as compared to the same periods in 2013. The improvement came primarily from Agency mortgage-backed securities. The effect of slower refinancing volume evident during the first half of 2014 has resulted in less principal repayments from Agency mortgage-backed securities, which has caused monthly amortization expense to be recognized more slowly. While quarterly and year-to-date interest revenues from Agency mortgage-backed securities have decreased $78 and $211, respectively, from a year ago, amortization expenses have lowered by $209 and $436, respectively, to completely offset the decline in interest.

Total interest expense incurred on the Company's interest-bearing liabilities decreased $185, or 20.0%, during the second quarter of 2014, and decreased $518, or 26.1%, during the six months ended June 30, 2014, as compared to the same periods in 2013. The decreases were primarily due to a sustained low-rate environment that has impacted the repricings of various Bank deposit products, especially time deposit balances, which continued to reprice at lower rates during 2014. As a result, the Company's weighted average costs for time deposits decreased from 1.22% at June 30, 2013 to 0.85% at June 30, 2014. The Company also continues to experience a deposit composition shift away from higher costing average time deposits to lower costing average interest- and non-interest bearing core deposit balances. As a result, the Company's average time deposit balances decreased $24,421, or 12.5%, while average interest- and non-interest bearing core deposits increased $28,162, or 5.6%, during the first six months of 2014 when compared to the same period in 2013. As a result of decreases in the average market interest rates and the continued deposit composition shift to lower costing deposit balances, the Company's total weighted average costs on interest-bearing deposits have lowered 17 basis points from 0.65% at June 30, 2013 to 0.48% at June 30, 2014.


Further impacting lower funding costs was a decrease of $99, or 54.7%, in interest expense incurred on the Company's subordinated debentures during the first half of 2014 compared to the first half of 2013. The Company redeemed one $5,000 trust preferred security classified as subordinated debentures during the first quarter of 2013. The redemption relieved the Company of incurring expenses on $5,000 at a fixed-rate of 10.6%.

During 2014, the decline in asset yields was completely offset by a larger decline in funding costs. As a result, the Company's net interest margin improved 13 basis points to 4.46% during the second quarter of 2014, and 12 basis points to 4.49% during the first half of 2014, as compared to the same periods in 2013. The Company will continue to focus on re-deploying the excess liquidity retained within the Federal Reserve account earning 0.25% into higher yielding assets as opportunities arise. The Company will continue to face pressure on its net interest income and margin improvement unless loan balances . . .

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